Need for Social Security Reform Passage and Uncertainty over Presidential Race Key Themes at EMTA Forum in Sao Paulo

Despite the wide-spread search for answers in Brazil’s upcoming elections, all the noted political analyst Murillo De Aragao declared he could offer in his keynote address at EMTA’s Forum in Sao Paulo was “uncertainty.” The event was held on Tuesday, May 8, 2018 and was sponsored by MarketAxess. Fitch Ratings and UBS provided additional support for the program.

De Aragao opened his remarks with a review of the long-term effects of the Car Wash scandal. In his view, three main consequences from the affair included a broad desire for renewal, a growing intolerance to corruption and greater political radicalism. The resulting changes in campaign financing (such as the ban on corporate donations and donation caps) have led to a new model on how presidential campaigns are run, and a shortening of the race.

“Conventional wisdom was that by this time of year, there would be more clarity on the Presidential candidates, and the political alliances,” but the lack thereof was creating, “great anxiety in the market.” Several candidates had cropped up, only to subsequently disappear, and “I don’t know” is leading voter intentions, he summarized.

De Aragao observed that, “renewal” candidates, such as former Supreme Court Justice Joaquim Barbosa and Jair Bolsonaro, when combined, together garner 50% of the vote. “However, they have no common political theme, so it’s an open question whether, should one drop out, their votes go to other ‘renewal ‘candidates.” (A point made more salient when later that day Barbosa announced he would not seek the presidency.) While imprisoned former President Lula maintained a loyal base of supporters, and could have some influence, his Workers Party no longer had the same strength as in the past, he stated.

The race for lower House seats was also pivotal, and De Aragao highlighted the importance of body’s Speaker. “Our Senate has an aura of a House of Lords; in the end what really determines policy in Brazil is the lower House,” he asserted. The race for lower House seats could lead to a hodgepodge of tactical alliances between parties, who might compete in other districts, as each party strategized how to maximize its Congressional power. As a result, just having candidates in each race, “can be a bargaining chip in the process,” he explained.

Social media will play a greater role in the election, at the expense of more traditional media, in De Aragao’s view. “There will be no more of the old ways of ‘brainwashing;’ you can set up your own filters of how and when you want your information.” However, the full impact of firms such as Facebook and Twitter was not yet obvious; “I don’t know if they can actually tip the scale,” he admitted.

De Aragao expressed hope that the eventual winner would be market-friendly. He underscored the need for public-private partnerships, especially in a country where large construction companies had been damaged by the corruption scandal. He also voiced optimism that that the social security reform bill, while not having enough support to pass, had garnered a respectable number of votes; “that shows a level of maturity in politics.” A panel discussion moderated by Rafael Guedes of Fitch Ratings followed. Guedes reminded attendees of his firm’s decision to downgrade Brazil to the BB- level in February, “although the good news is that for the first time in three years, we now have a stable outlook on our Brazil rating.” Guedes compared Brazil to other BB- credits, observing that, “Brazil’s debt/GDP ratio is high, but it also has some better statistics than its peers, such as higher average per capita income.” Crucial factors would include the government’s ability to cut spending in the event of declining revenues, and both the make-up of the next economic team and its goals.

Guedes invited speakers to share their own thoughts on the outlook for Brazilian politics. Alexandre Carlos Lintz (Garde Asset Management) highlighted recent progress, including the spending cap, the removal of subsidies, and a growing recognition—as demonstrated by the increased support of the social security reform—that “the party is over.” Lintz declared that the baseline has changed, with discourse on reforms occurring on both left- and right-wings, “and this makes progress more possible.” Candidates such as Bolsonaro and Geraldo Alckmin appear to support the social security bill, he noted. Meanwhile, the extreme left, which opposes the Temer reforms, have lost ground.

“Brazil is not for beginners,” commented UBS’ Tony Volpon, who pointed out that President Temer, before spearheading recent reform passage, had been a vice president in the PT-led coalition government. Volpon was optimistic that the new administration would be reformist, “and this cycle will persist, even though I’m not sure who will be elected.” With the vast majority of local debt held by Brazilians, who thus have “skin in the game,” officials in Brasilia should recognize the link between financial and economic instability and their own political survival, he warned. Recognizing that the Temer government would pursue no further reform action in its remaining months in office, Volpon stated that, “the issue is how impatient will the market be to the new administration, how much time will they get?”

Long-time industry veteran Paulo Leme stressed that Brazil’s next administration would need to face the challenge of tougher reforms. “We need some painful cuts; we need to broaden reforms so we can boost growth and improve savings; we need to privatize sectors that will boost productivity.” Leme believed that any new reformist government was likely to adopt a gradualist approach, which raised the issue of more missed opportunities. “We have lost a lot of foreign trade to other countries, and we may not have the time to catch up,” he warned. “It’s clear what needs to be done,” summarized Aduato Lima (Western Asset Management). “What’s not clear is if the political class has the will to get it done.”

Leme and Lima estimated Brazilian growth at between 2 and 2.5% in 2018. Leme expressed concern that the lack of investment continued to rein in Brazil’s potential. “The Temer government worked on stabilization, but forgot about productivity.”

Volpon discussed recent dollar strength, expecting momentum to lose steam as US inflation decelerates. Dollar weakness in the past year had surprised the markets, and the reason for both its 2017 weakness and recent strength, remained somewhat unclear. “We should act with some concern as a stronger US dollar and higher US rates could create problems for Brazil…it’s not a secret that we have a lot of corporate debt denominated in US dollars,” he stated. Volpon advised investors that it was “yellow flag” time, and urged his former employer, the Central Bank, to act more aggressively and take preventive action to avoid being behind the curve.

Leme predicted that the US yield curve was more likely to become steeper rather than flat, and deemed the risk of the 10-year UST surpassing 4% as high, though specifying that this was unlikely in the short-term. “There will be a ditch in the road, but we don’t know at what kilometer it will be,” he stated, and repeated the call for further reforms in a deteriorating external environment. The choice for the economic future was now up to Brazilians; “we are much more in control of our destiny.”